Pages

Tuesday, May 28, 2013

Putting a Collar on Carbon Prices

Severin Borenstein has written a post, at the Energy Institute at Haas' Energy Economics Exchange blog, using the European Union's struggling Emissions Trading System (EU-ETS) to demonstrate the design failures of that scheme, and the implications for better system design.

... the most recent disappointment — the extremely low prices of current permits — while not completely predictable, were a clear risk when the program was launched. Unlike California’s cap and trade program, the EU-ETS has no price floor. As a result, when lower-than-expected emissions occurred – due primarily to the anemic EU economy – the price was likely to crash. With prices now around 3 euros (equivalent to about a 5 cent per gallon tax on gasoline), the EU-ETS is providing very little incentive to take actions that reduce emissions.
But if the emissions targets are being met at that price, what’s the problem? Why is the market being called a failure or irrelevant? Because nearly all observers recognize that it makes no sense to stick to a rigid quantity target for EU greenhouse gas mitigation when the real goal must be long-run development of alternatives to fossil fuels and other GHG emission sources. In particular, alternatives that are economic enough that the developing world might be enticed to adopt them.
The EU reductions alone aren’t going to shift the path of earth’s warming, so pretending there is a fixed target simply ignores the science of climate change. Instead, we should recognize that the market (remember, this is a market-based approach to emissions control) needs some stability in price signals to make investment plans. That’s the role of a price floor.